Student Housing Graduates

Student housing has joined the grown-up world of money making, but will the current influx of investors succeed in this tough new market?

Since 2001, investment volume in student housing has grown from virtually zilch to more than $2 billion in both 2005 and 2006, according to Real Capital Analytics. Just four years ago, no REITs specialized in student housing. Now, three focus on the sector. There are other signs of the young market's growing strength:

American Campus Communities, which went public in 2004, owns or manages 42 properties with 26,400 beds, and provides leasing and management services to other owners of properties for students.

GMH Communities Trust, based in Newtown Square, Pa., went public in 2005 and owns 77 student properties totaling about 47,000 beds.

Education Realty Trust, based in Memphis and also public since 2005, owns or manages 66 properties with 40,742 beds.

The major REITs also are building. American Campus recently broke ground on the first phase of the South Campus Residential Community at Arizona State University in Tempe, which will include 1,866 beds. When completely built out, the project could include up to 5,100 beds. In an unusual twist, the property is owned by the university, but the REIT holds it through an 85-year ground lease.

Much new housing nationwide sits in stark contrast to the former cinder-block cells with institutional paint. What does it cost? While there are no national statistics, the average weighted monthly rents for the three REITs comes to $1,194 per unit, or $371 per bed.

The surge in interest stems in part from the demographics. The leading edge of the so-called echo boomers, people born between 1982 and 2000, is now of college age and about 74 million strong.

Rising enrollment and returns

The trend is more than a matter of population numbers. Enrollment in colleges and universities is higher than ever before, with about 67% of all high school graduates continuing on to college as of 2004, according to the National Center for Education Statistics. That compares with 45% enrolling in 1960. Furthermore, nearly 3 million students will enroll in a U.S. college each year during the 2010s.

An aging stock of housing awaits new collegians. A 2004 National Multi Housing Council (NMHC) survey of 1,500 off-campus properties in 64 college towns nationwide found that a majority of the properties were at least 20 to 30 years old.

Student housing properties are more attractive in terms of price relative to standard multifamily housing. Student housing is currently trading at somewhat more favorable cap rates than apartments — 75 basis points higher, according to Michael H. Zaransky, co-CEO of Northbrook, Ill.-based Prime Property Investors Ltd., which has acquired properties near the University of Nebraska, Florida State University, and the University of Indiana in Bloomington, among others.

The spread between standard multifamily and student housing has narrowed in recent years, however. “In 2004, cap rates were about 8%, or 150 to 175 basis points higher than comparable multifamily,” recalls William C. Bayless Jr., president and CEO of Austin-based American Campus Communities.

“In the most recent acquisitions we've done, cap rates have been about 6.25%, and we've seen other investors buy below 6%,” says Bayless, who largely attributes the shift to the influx of capital for student housing deals. He characterizes some of the trend as “uneducated capital partnering with inexperienced operators.”

“Cap rates have definitely narrowed as student housing has come to be considered a core asset,” explains Jason Mattox, executive vice president with Addison, Texas-based Behringer Harvard, which has provided about $100 million in mezzanine financing to student housing. “Returns are still favorable when compared with multifamily, though it's hard to find good properties.”

Returns are higher in student housing because vacancy and collection loss issues are almost non-existent, Zaransky says. Still, student housing is more management intensive, and turnover costs are higher.

Occupancy rates close to 100% are not uncommon near campus, he says. “And it's very rare for student housing property to go to collection because there's generally more than one roommate on the lease, along with parental guarantees.” That makes for lower operating costs than apartments.

Rents are expected to grow, although substantiating data is scarce. Indicators show student rents have been rising well ahead of inflation, noted a report by RREEF Real Estate Research in April. But with the limited track record of the student housing REITs, rents haven't been reliably tracked over time.

Still, a 2006 update of the NMHC student housing survey of 64 markets found that rents rose an average of 7% from 2004 to 2006, or 3.4% annually. American Campus Communities predicts similar growth for its off-campus portfolio, anticipating rents on 2007-08 leases will rise 3.9% over the previous academic year.

Market freshmen, beware

Seasoned players, of which there are only a few in this specialized market, say that there are many pitfalls for newcomers. “Whenever apartment owners ask me about student housing, I admonish them that it isn't for the faint of heart,” says Gary Tenzer, managing director of Los Angeles-based George Smith Partners, which finances student housing.

“If you see student housing managed by a company whose primary business is multifamily housing, there's a strong chance it doesn't know what it is doing.”

There's a big difference between student and multifamily leasing patterns. “In some markets, landlords are able to get 12-month leases in the most desirable buildings,” notes Tenzer. But in many markets, landlords can't get year-long leases. Often student housing is leased for about 10 months. “You can't count on leasing over the summer,” he says. “Your cash flow is lumpy.”

The length of the lease, however, isn't as much of a concern as the timing. Each year, landlords have a narrow window of leasing opportunity, and it's an all-or-nothing game.

If an owner leases the property during the window, everything is set for the year. If not, the owner may have lost the chance for a full year. “You have to know exactly when the leasing cycles are because you get only one shot at it,” says Bayless.

Keeping track of leasing cycles isn't generally a problem with local ownership and management, he says. But an investor whose business plan calls for acquiring 20 student properties a year may encounter difficulty. For an investor unfamiliar with a new market and its leasing cycles, it's harder to manage the properties.

The timing of a project's delivery is also critical. “The construction period has to be right because you have to be finished for the fall of the school year,” says Chris Harness, a San Antonio-based senior vice president at Trammell Crow Co. who is responsible for building the firm's new student housing development business. “If you're late, you're dead. The worst thing you can do is not have the property ready when the students show up.”

Study the submarkets

Local factors are more important to the success of student housing than in any other property type. The students' world revolves around the university or college, and no school is quite like any other, in student body, campus layout or stock of existing housing, whether on or off campus. Landlords need to watch school enrollment trends, since enrollment growth means rent growth and increased cash flow, says Zaransky.

Investors say the economy, job formation and population growth don't usually affect student housing as much as local supply and demand, and owners need to be observant. “Sometimes there are radically different student housing submarkets within blocks of each other serving the same university,” Tenzer notes.

Harness agrees, pointing out that his access to a network of CB Richard Ellis brokers is critical to keeping tabs on student housing markets nationwide. “The only way you have a chance is to act local, know local, be local,” he says. “A developer based in San Antonio, for instance, isn't going to know about Memphis.”

Harness learned of an opportunity in Memphis, he recalls, when a broker there called to tell him about a one-acre site on the market two blocks from the University of Memphis. “‘Are you interested?’ he asked. I definitely was. It was the kind of opportunity you'd notice only by being on the ground.”

The Memphis project, which calls for 255 beds of student housing, is under construction. Trammell Crow also has 260 student housing beds under construction in Philadelphia and another 390 ready to break ground in Brownsville, Texas.

Solid deals, strong closers

Investors and developers cope with the pitfalls of college-area housing in various ways. Strategies include competing and winning properties in markets that are difficult to enter, setting up proprietary management systems, or partnering with local management firms. At the very least, companies are compelled to research local markets.

“Our strategy is to buy existing, stabilized properties with an operating history that we can underwrite — a history of rent growth and occupancy,” says Zaransky. Prime Property Investors requires sites to be within walking distance of campus and near schools that are expected to experience enrollment growth over the next few years.

There's stiff competition for properties in tight markets. “We compete for them by establishing a reputation as closers,” Zaransky says. “Our equity and debt are lined up, and we've never failed to close on a transaction that we are under contract for, and our sellers know that.”

As for management issues, Zaransky advises using local contacts. “We spend a lot of time on asset management. That means daily contact with our third-party managers. Oversight of all the properties is a time-consuming function, but absolutely necessary.”

American Campus Communities developed a proprietary asset management system for its properties long before it became a public company. “Student housing is highly specialized from an operational perspective,” Bayless says. “There are no off-the-shelf operating or marketing and leasing or accounting systems for the sector, so you have to do it yourself. It takes a lot of time.”

Bayless also emphasizes the critical importance of being close to campus. “You don't want it far away,” he asserts. “You want it to be a walk or a bike ride, or at most a short shuttle ride from campus.” Developing further from campus may be easier, but it's riskier in terms of leasing and competition.

“Projects aimed at students have been developed as much as five miles from campuses because zoning is favorable, land plentiful, and typically there's no local opposition,” says Bayless. The problem is that the same factors make it easy for other developers, Bayless adds.

He cites an example of a distant cluster of student housing developments in Austin that didn't do well. “From 1998 to 2002, about 8,000 beds were built in a submarket roughly three miles from the University of Texas, which has had a stable enrollment of 48,000 to 50,000 for the last decade,” he says. “That submarket has cratered,” says Bayless. “At its worst point, occupancies and rental rates declined about 20%, and about a quarter of those properties are in foreclosure. They couldn't compete.”

Learn the granular details

Success in student housing also means understanding what each market can sustain. Generally, private universities support more expensive properties with costlier amenities, but if successful, they quickly return the investment.

But private universities often cap their enrollments, forestalling growth opportunities. On the other hand, expanding public universities whose students are willing to live in more basic accommodations will support new properties and future rental growth, even if the properties don't sport every bell and whistle.

These days, Internet access is as basic a feature of student housing as kitchens and a laundry room. Upscale properties may include fitness centers, sports courts, computer rooms and swimming pools. A few amenity-laden properties also include concierge service and coffee bars.

“At USC, we financed a higher-end building, but our other locales don't have quite the amenities,” says Tenzer, adding that students demand more amenities these days, and get some of them, “but most aren't actually going to get the very posh amenities that the mainstream media likes to talk about. Upscale gets the attention, but it isn't the only way to make money in student housing.”